FINANCIAL INNOVATIONS LAB® New Models for Funding Post-Secondary Education in Illinois About the Milken Institute The Milken Institute is a nonprofit, nonpartisan think tank. We catalyze practical, scalable solutions to global challenges by connecting human, financial, and educational resources to those who need them. We leverage the expertise and insight gained through research and the convening of top experts, innovators, and influencers from different backgrounds and competing viewpoints to construct programs and policy initiatives. Our goal is to help people build meaningful lives in which they can experience health and well-being, pursue effective education and gainful employment, and access the resources required to create ever-expanding opportunities for themselves and their broader communities. About Financial Innovations Lab® Financial Innovations Labs® bring together researchers, policymakers, and business, financial, and professional practitioners to create market-based solutions to business and public policy challenges. Using real and simulated case studies, participants consider and design alternative capital structures and then apply appropriate financial technologies to them. ©2020 Milken Institute This work is made available under the terms of the Creative Commons AttributionNonCommercialNoDerivs 3.0 Unported License, available at creativecommons.org/licenses/by-nc-nd/3.0/. Acknowledgments Maressa Brennan prepared this report. We are grateful to those who participated in the Financial Innovations Lab for their contributions to the ideas and recommendations summarized in this report. We would especially like to thank the Office of the Illinois State Treasurer Michael W. Frerichs for its partnership on the project. We want to thank our Milken Institute colleagues Caitlin MacLean, Théo Feldman, Jason Davis, Michelle Mountain, Rodrigo Bettini, and Danielle Andino for their work on the project. Finally, we would like to thank Editor Dinah Nichols for her work on the report. CONTENTS 1 Introduction 3 Issues and Perspectives 3 State of the Market: United States 7 Funding and Repayment Options 10 State of the Market: Illinois 11 Barriers 11 Incomplete Risk Assessment Leaves Students Behind 12 A Complicated Borrowing Process 13 Current Private Loan Terms Are Onerous 14 Student Debt Programs Can Be Misaligned with Education Outcomes 16 Minority and Low-Income Students Have Disparate Access and Outcomes 18 Impact of COVID-19 on the Student Loan Market 19 Innovative Solutions 19 Create a Statewide Education Impact Fund 19 Target Student Markets 21 Product Offerings 23 Eligibility and Underwriting Criteria 24 Critical Terms 24 Distribution and Partnership Options 25 Data and Metrics to Assess and Price Risk Effectively 28 Develop an ISA Program 28 Target Student Markets 29 Critical Terms 30 Distribution and Partnership Options 31 Consumer Protection 33 Create a Loan Navigator Platform 34 Relief for Borrowers Affected by COVID-19 35 Conclusion 36 About The Author 37 Participant Lists 42 Endnotes INTRODUCTION Education is largely recognized as a gateway to career options and upward mobility, both in the groundwork it lays for job opportunities and the critical thinking it fosters. A high-school diploma can be the basis of a fulfilling profession, but a college (post-secondary) degree alters one’s lifetime earnings dramatically. In 2015, according to the Social Security Administration, a man holding a bachelor’s degree would earn $900,000 more in median lifetime earnings, and a woman some $630,000 more than their high school-educated counterparts would.1 “An investment in knowledge pays the best interest,” wrote Benjamin Franklin in 1758. Yet while few would deny the intrinsic value of a college degree, for some years now, an increasing number of students, researchers, and policymakers have begun to weigh the immense debt burden associated with tuition and related costs against today’s tangible outcomes. A 2018 Atlantic magazine article looked at the Organization for Economic Co-operation and Development (OECD) data to examine the state of higher education in 46 developed and G20/OECD accession countries. They found that, at $30,000, the average annual US “investment” in education—which With costs and debt includes not only direct family payments but also private grants loads continuing to and public funding—was twice the average among reporting countries, and that the “interest” on that investment was rise, it is imperative questionable.2 Meanwhile, the student loan debt crisis hit to expand and a record with the Class of 2020, according to a compilation “ of data by Forbes, which notes that student loans are the enhance equitable second-highest consumer debt category, ranking behind only financing options. mortgages. Some 44.7 million student loan borrowers owe on average $32,721 individually, for a total of $1.56 trillion.3 With costs and debt loads continuing to rise, it is imperative to expand and enhance equitable financing options. Illinois has been at the forefront of addressing this issue. The Illinois Legislature and the Office of Illinois State Treasurer Michael W. Frerichs (“Treasurer” or “Treasurer’s Office”) have worked for several years to develop accessible, affordable, and innovative mechanisms by which students can finance or refinance their post- secondary education. A major achievement has been the Student Investment Account Act, spearheaded by Treasurer Frerichs and signed into law by Governor J.B. Pritzker in August 2019 as a supplement to current state and federal student loan and grant programs. The new law establishes the formation of a Student Investment Account, to be designed, implemented, and managed by the Treasurer and administered as an impact investment portfolio aimed to balance measurable social benefits with financial returns. MILKEN INSTITUTE NEW MODELS FOR FUNDING POST-SECONDARY EDUCATION IN ILLINOIS 1 The law gives the Treasurer the authority to allocate an annual investment of 5 percent (approximately $800 million at current estimates) from the State Investments portfolio, on an ongoing basis, into the new investment account. As of summer 2020, the funds were expected to be invested as follows: $200 million to fund low-interest loans for underrepresented and low-income students and families who cannot access credit; $550 million for refinancing student loans at below-market- rate to help graduates with their outstanding debts; and $50 million for innovative products, such as income share agreements, which are equity-like investments in a student’s education for which repayment is based on a percentage of future salary for a set number of months or years. The target returns on investment—coming from the repayments of loans and new refinancing products—can be low. In the nature of an impact investment vehicle, the funds could earn below-market-rate returns, from just above 0 percent to perhaps 2-3 percent, to allow for the capital to recycle and plow back into the State Investments portfolio, or be utilized to provide loan forgiveness, loan forbearance, loan deferments, hardship assistance, scholarships, and/or educational grants. In June 2020, the Milken Institute, in collaboration with the Office of the Illinois State Treasurer, organized two virtual Financial Innovations Labs to explore how the state’s $800 million capital investment in higher education finance could have the most significant impact. The Lab brought together educators, government leaders, investors, loan servicers, consumer protection experts, alternative loan providers, and state agencies to develop recommendations to expand the range and availability of traditional loan products and refinancing options, as well as introduce newer financing options. Financial Innovation Lab Virtual Zoom Participants MILKEN INSTITUTE NEW MODELS FOR FUNDING POST-SECONDARY EDUCATION IN ILLINOIS 2 ISSUES & PERSPECTIVES State of the Market: United States More adults than ever are getting post-secondary degrees. In 2018, 47 percent of all US adults held at least an associate’s degree, up from 38 percent in 2000, according to data compiled by the US Department of Education’s (ED) National Center for Education Statistics (NCES). While 29 percent of adults held at least a bachelor’s degree in 2000, that share had grown to 37 percent in 2018. Also, in 2000, just 5 percent of US adults held at least a master’s degree; in 2018, that number had nearly doubled to 9 percent.4 These increases may be due in part to worsening employment in traditional manufacturing and service-sector jobs. But opportunities in fast- changing sectors like health care, data science, computer science, green technologies, and artificial intelligence no doubt also play a role. Also worth mentioning is credential inflation—jobs that previously did not require a degree and now do. Unfortunately, the lure of a college degree is often marred by fear of a debt burden that may compel the borrower to forgo homeownership, delay starting a family, or be Factors Delayed unable to save for retirement. Research by the Federal by Student Debt Reserve found that “a $1,000 increase in student loan debt • Saving for (accumulated during the prime college-going years and retirement measured in 2014 dollars) causes a 1 to 2 percentage point drop in the homeownership rate for student loan borrowers • Buying a house during their late 20s and early 30s.”5 A 2015 study by • Starting a family American Student Assistance learned that 62 percent of • Paying off other student loan borrowers put